Co-authored by Byron Villacis
On the corner of a bustling, working-class neighborhood in Mexico City, Maria Gonzlez* has run a small photography business for years. Recently, she took out a bank loan to purchase a new digital camera and printer that enabled her to produce high-quality images and deliver them at a rapid speed. Gonzlezs clients noticed her improved service and spread the wordnew customers flooded her store. A few steps down the same street, Andres Perez owns a bookstore that would benefit from renovations. While these improvements would presumably attract much needed customers, Perez refuses to take out a bank loan. He explains that bank loans are stressful, require too much paperwork, and are meant for people with money or assets.
Financial inclusion brings major benefits to individuals like Gonzlez and entire economies. By allowing people to invest in their future, smooth consumption, and manage risk, access to and use of a range of financial services help reduce poverty and inequality. Yet, access to financial capital is often cited as a barrier to growth for microentrepreneurs in emerging countries. In these countries, 40 percent of formal micro-, small- and medium-size enterprises are financially constrained.
But, as Perezs story demonstrates, unmet financial needs among microenterprise owners may also be a result of low demand for the formal financial services available to them. Despite the availability and benefits of loans through banks and microfinance institutions (MFIs) in Mexico, take-up rates of formal financial products among microentrepreneurs is often surprisingly low. For example, only 4 percent of eligible applicants take up the credit available to them from Mexican bank and MFI Compartamos Banco. A new report by the Institute for Business & Social Impact at the Haas School of Business, University of California, Berkeley, in partnership with the Mastercard Center for Inclusive Growth, surveys microenterprise owners clustered at the bottom of the pyramid in Mexico and investigates possible reasons for their disinterest in formal financial services.
The formal versus informal financial system
The new report presents evidence that small business owners in Mexico prefer informal financial networks to the formal financial system. In the sample of more than 1,300 Mexican microentrepreneurs, over 75 percent do not consider borrowing from the formal financial system in times of economic need. Rather than take out a bank loan or MFI credit, more than two-thirds of these entrepreneurs would prefer to draw from their personal savings or borrow money from a friend or relative, and about 10 percent would sell belongings in exchange for cash. Interestingly, this is true among microentrepreneurs in the sample across all levels of education, suggesting that it is not lack of information or understanding that is compelling these small enterprise owners to avoid formal financial products.
The report goes further, inquiring what features of formal bank and MFI loans are unappealing to microentrepreneurs. Their aversion to collective loans stands out as an explanation. To guarantee high repayment rates, discourage risky projects, and increase accountability, formal banks and MFIs will often require microenterprise owners to apply for credit with a group of peers or neighbors. All group members would be penalized if the loan is not fully repaid. While collective loans are designed by banks and MFIs to increase credit availability to microentrepreneurs without collateral or prohibitively high interest rates, this design feature appears to discourage eligible borrowers in Mexico. Even in times of economic distress, the majority of Mexican microentrepreneurs surveyed would prefer an individual loan, citingas reasons personal responsibility for repayment, flexibility of credit to individual business dynamics, difficulty in meeting group eligibility requirements, and higher loan amount disbursed.
These results suggest that specific design features of formal bank loans and MFI loans intended to serve microentrepreneurs clash with their preferences, and inadvertently keep them on the periphery of the formal financial system.
Technology and financial inclusion
Cell phones and digital technologies are likely to provide the platforms necessary to increase financial inclusion for microentrepreneurs in the informal and formal economy. The report finds that over three-fourths of microenterprise owners in the sample own a cell phone. However, only 14 percent of cell phone owners use their mobile device for business-related transactions. Mobile channelsperhaps developed by formal financial institutionscould be used to track transactions, customers, and revenue to determine eligibility for individual loans, as well as monitor credit dispersion and repayment rates. Targeted programming that encourages business-related cell phone usage and training could lead to efficiency gains and unleash potential for microentrepreneurs. The cell phone market in Mexico is projected to keep growing, providing opportunities for value-added services that have the potential to increase financial inclusion and market share for microenterprise owners.
These findings suggests that digital technologies might enable banks and other financial institutions to design better products that encourage microentrepreneurs to engage in the formal financial system. Indeed, mobile money and other forms of digital finance are likely to be the major channels for accelerating progress on financial inclusion in Mexico and other emerging market economies. Of course, in addition to technology, there are various factors that influence a microentrepreneurs demand for a loan, including low trust in formal banks and the government, fear of debt, sensitivity to interest rates, and lack of information.
Strivers in Mexico
To facilitate smooth transactions between banks and microentrepreneurs, banks must be familiar with microentrepreneurs business profiles, characteristics, and motivations. The report points out that microenterprise owners in Mexico vary significantly with respect to their level of education, number of clients per week, volume of sales, and amount of loans received in the past year. These findings indicate that it might be possible to determine the demand for financial products by individual microentrepreneurs based on their level of education or the size of their business.
As financial inclusion increases, some microentrepreneurs may be especially well positioned to benefit. The report proposes a framework to identify and classify this particular category of microentrepreneurs, termed " strivers "by the Mastercard Center for Inclusive Growth. Strivers are operating enterprises with two to 10 employees in rapidly growing market segments. They are poised to thrive and contribute to inclusive employment and economic growth within their communities, but are lacking the tools to increase their competitiveness and fully realize their business potential. The majority of respondents (60%) surveyed in the report are strivers by this definition.
Strivers, like most of the microentrepreneurs in the sample, prefer informal and individual loans, and are likely to own a cellphone. For strivers in Mexico, mobile devices may serve as important tools for information, training, and capital that lead to growing market share. The majority of the Strivers in the sample chose to be entrepreneurs over pursuing formal jobs; have a distinct sense of agency in their lives; and, as a result, believe that they have more control over their business outcomes.
This report provides an initial window into the lives and decisions of microentrepreneurs and strivers in Mexico. It highlights their need for credit to stimulate growth; specific barriers that keep them from taking-up loans from formal financial institutions; and the potential for mobile phone technologies to increase their engagement with these institutions. Impact-oriented design and evidence-based evaluation of financial products tailored to the needs of microentrepreneurs have the potential to vastly increase financial inclusion in emerging economies around the world. Bold approaches are necessary to realize the vision of sustainable growth for this promising segment of the economy.
* Names have been changed to maintain anonymity.
Laura D. Tyson is Interim Dean of the Haas School of Business and Faculty Director, Institute for Business & Social Impact, University of California, Berkeley.
Byron Villacis is a PhD candidate, University of California, Berkeley.